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Chesapeake Energy Corp., which has used a variety of savvy financial means to raise money for exploring and developing its vast unconventional portfolio in the United States, is preparing to launch its diverse onshore oilfield services unit through an initial public offering (IPO), a separate company that would continue to be closely tied to its main customer, the Oklahoma City-based producer.

Chesapeake last fall reorganized the oilfield services operations into Chesapeake Oilfield Services (COS), which CEO Aubrey K. McClendon said at the time might be worth as much as $10 billion this year (see Shale Daily, Sept. 20, 2011). According to Chesapeake's year-end filings, COS booked $1.3 billion in sales last year. In a Form S-1 filing with the Securities and Exchange Commission (SEC) late Monday, the IPO noted that the company hopes to secure funding of up to $862.5 million.

"We intend to aggressively grow our asset base, particularly our hydraulic fracturing [fracking] fleets, oilfield rental inventory and drilling-related services, in order to achieve our objective of increasing our productive capacity to meet up to two-thirds of Chesapeake's expected need for our services," the SEC filing said. "We have placed substantial orders for additional new hydraulic fracturing units and expect to have eight fleets with approximately 315,000 hp in the aggregate operating by the end of 2012 and 12 fleets with approximately 450,000 hp in the aggregate operating by the end of 2013."

The IPO filing comes at a critical juncture for Chesapeake, whose share price hit a 52-week low on Monday, closing at $19.05/share. A year ago the company was trading at about $35.75/share.

Before the IPO was announced, Citigroup on Monday cut its rating on the producer to "neutral" from "buy" and trimmed the price target to $22 from $28, citing near-term gas price headwinds. Chesapeake's [CHK] risk to filling large funding gaps "in a downside scenario over the next two years is growing and by far greater for CHK than for any other company in our coverage group." Morgan Stanley also on Monday cut its rating to "hold" because of gas prices. Morgan Stanley said there was "more downside than upside" to its estimate.

Chesapeake, the second largest natural gas producer in the United States, last year spent close to $13.3 billion to drill and complete 1,662 wells using more than 130 drilling rigs, the SEC filing said. By comparison, ExxonMobil Corp., the largest U.S. gas producer, last year had less than half that number of rigs in operation in the United States, according to its year-end filings. Smith Bits reported that on April 13 Chesapeake was running 161 rigs in the United States, versus 58 rigs for ExxonMobil.

According to data compiled by NGI's Shale Daily, Chesapeake also is holding more total net debt than integrated producer ExxonMobil. At the end of 2011, Chesapeake's total debt was $13.3 billion net, excluding minority interests, and $14.5 billion net, including minority interests. By comparison, ExxonMobil at the end of 2011 carried $4.37 billion net debt, excluding minority interests, and had $10.7 billion net debt, including minority interest. The figures excluded off-balance sheet debt items, including pipeline take-or-pay contracts, as well as volumetric production payments. In addition, ExxonMobil's market capitalization currently is 32 times that of Chesapeake's.

Canaccord Genuity energy analysts John Gerdes and Ryan Oatman said in a note Tuesday the IPO filing to raise as much as $862.5 million "implies an enterprise value of $4 billion" for the oilfield services unit, "assuming the company offers 20% of the unit to the public." COS debt totaled $1.05 billion at the end of 2011, the analysts said. "Compared with major integrated service providers, this valuation appears elevated" for 2012 earnings but in line with 2013 earnings. "Further, we believe this valuation is appropriate given the unit's growth and lower volatility given Chesapeake drilling and frack fleet utilization guarantees."

Once the IPO is completed, COS would become a holding company and would control all of its businesses. However, COS would be tied to Chesapeake long after it's a standalone company. It has, among other things, a master services agreement in place with the oil and gas drilling powerhouse, under which it provides services, supply materials and equipment to Chesapeake, while Chesapeake operates a minimum number of the COS drilling rigs and uses its fracking equipment for a minimum number of frack stages per month. The companies also have an administrative services agreement and a facilities lease agreement in place.

And Chesapeake, which currently holds all of the Class B common stock, would continue to have a percentage of the combined voting power of the outstanding common stock not sold and would "continue to control our business...and be able to control all matters requiring the approval of our shareholders, including the election of directors and the approval of significant corporate transactions," the SEC filing said. "As the driller of a substantial majority of Chesapeake's wells, we play a central role in the planning and execution of Chesapeake's drilling program," COS said. "As a result of this role, we are uniquely positioned to cross-sell our other service offerings to Chesapeake, observe the service offerings of other third-party service providers that are present at the well site and evaluate expansion opportunities. We plan to use this role to focus our growth on high margin product and services offerings."

During 2012 and 2013 COS plans "to make $1.1-1.2 billion of growth capital expenditures, in addition to amounts budgeted for the acquisition of presently leased rigs, and these expenditures will allow us to meet a greater percentage of Chesapeake's needs and solidify our position as one of the largest U.S. onshore oilfield services companies."

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